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African Journal of
Business Management
Volume 9 Number 1 28 January, 2015
ISSN 1993-8233
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Table of Contents: Volume 9 Number 2 28 January, 2015 ARTICLES Research Motivational factors of formation, cooperate actions and gains obtained from the cooperation networks of building material retail in Parana: A comparative between the associated managers’ and retailers’ perceptions 35 Sandro Deretti, Loise Schwarzbach, Luciano Dalazen, Anderson Catapan* and Claudimar Pereira da Veiga Networking for SMES in Uganda: A conceptual paper 43 Peter Turyakira* and Cathy Ikiror Mbidde The relationship between some demographic variables and leadership effectiveness among local government managers in South Africa 50 Clement Bell, Roelf Rvanniekerk and Petrus Nel The impact of credit risk on profitability performance of commercial banks in Ethiopia 59 Million Gizaw*, Matewos Kebede and Sujata Vol. 9(2), pp. 35-42, 28 January, 2015
DOI: 10.5897/AJBM2014.7579
Article Number: C8AE13550090
ISSN 1993-8233
Copyright © 2014
Author(s) retain the copyright of this article
http://www.academicjournals.org/AJBM
African Journal of Business Management
Full Length Research Paper
Motivational factors of formation, cooperate actions
and gains obtained from the cooperation networks of
building material retail in Parana: A comparative
between the associated managers’ and retailers’
perceptions
Sandro Deretti1, Loise Schwarzbach2, Luciano Dalazen3, Anderson Catapan4* and Claudimar
Pereira da Veiga3
1
Universidade Estadual do Paraná – Campus Paranaguá, Brazil.
2
Universidade Federal do Paraná, Brazil.
3
Pontifícia Universidade Católica do Paraná, Brazil.
4
Universidade Tecnológica Federal do Paraná, Brazil.
Received 9 November, 2014; Accepted 19 January, 2015
This study analyzes factors that condition the formation of the building material of retailer cooperation
networks and the results obtained with this actuation. This study was carried out of multiple descriptive
and comparative cases, with transversal perspective of time. A non-disguised questionnaire was used,
answered online by fifteen associated retailers and the manager of each one of the four formally
incorporated networks acting on the field in the State of Parana, Brazil. On the basis of the answers
provided by these two groups of managers, it was raised similarities and differences about the
formation and gains obtained after entering these organizations. The study reveals that the main factors
for the formation of the networks are: a) development of collective actions; b) pursuit of stability in the
market; c) reduction of costs; and d) adaptation to the market conditions. The cooperated actions of big
interest among the networks managers are those turned to the projection of a brand in the market. The
main results obtained are: a) higher negotiation power with the suppliers; and b) exchange of
experiences, importance of the business management. The study highlights the different dimensions
for the constitution of the cooperation networks and that there are different perceptions regarding the
obtained results for the cooperated actuation.
Key-words: Retail, building material, cooperation network, formation, results.
INTRODUCTION
The globalized economy determines the deep changes in
the strategic process of the companies, propitiating
opportunities and threat on every segment and requiring
new ways to compete. On this environment of changes,
*Corresponding author. E-mail: [email protected]. Tel: +554199216026.
Authors agree that this article remain permanently open access under the terms of the Creative Commons
Attribution License 4.0 International License
36
Afr. J. Bus. Manage.
some organizations seek acting on a cooperating way in
order to face the problems related to costs, marketing,
employees’ training and others. For Balestrin and
Verschore (2008), cooperation allows seeking technologies and the reduction of transaction costs related to
the innovational process, increasing the economic
efficiency and, therefore, improving the levels of
competitiveness. In the retail scope, the approach of the
business cooperation networks allows achieving actions
previously inaccessible, specially the micro and small
companies that find it difficult obtaining resources
(Pereira, 2004; Castro et al., 2011).
In Brazil, the building material retail is prospering,
driven by the habitation politics and the distribution of
income applied by the federal government. The sales of
the sector contributed to 1.9% of the Brazilian GPD in
2011 billing more than R$ 76 billion (IBOPE, 2012). The
State of Parana counts with four building material of
retailer cooperation networks that together account 145
associated retailers, mostly micro and small companies,
acting in different cities. These organizations are formed
to achieve common goals of their members.
The goal of the current work is to determine the factors
that motivate the formation, the impacts on the
cooperated actions and the gains obtained by the
building material of retailer cooperation network existing
in the State of Parana, Brazil. The methodology consists
of a study of multiple cases, questionnaires answered by
the managers of the four networks acting in the segment
in Parana and by the retailers association.
This work is part of a wider study, still in development,
that seeks to comprehend the marketing strategic
formulation and implementation processes in the
cooperation networks in the State of Parana. The study is
structured in five sections that can be summarized this
way: the first section approaches the introductory part
and the goals of the study, the second handles the
theoretical empirical approach, the third represents the
methodological procedures, the fourth section presents
the data analysis and the fifth approaches the final
considerations and recommendations.
THEORETICAL EMPIRICAL ARPPOACH
The retail of building material in Brazil
The relevance of studying the retail and its activities is to
represent a manifestation of the marketing concept in the
exact moment good and services are delivered to the
consumers (Las, 2010). According to Vieira et al. (2012),
there is a strong tendency on which the Brazilian
researches increasingly accompany the market dynamic;
the retail activity is the right field for this kind of
investigation that involves the relation between theory
and practice.
According to the Annual Research of Commerce of
IBGE (2008) the quantity of companies acting in a retail
activity in Brazil accounts for more than 1.4 million
establishments in 2008. From this total, the retail activity
of building material congregates almost 145 thousand
companies. The productive chain is segmented into four
main groups: goods protection industry, building trade
industry, building material commerce, and specialized
services.
The retail building materials commerce is an important
part of the complex called Constru Business that involves
also capital goods for the construction and services that
in 2011 represent around 14% of the Brazilian GDP
(IBOPE, 2012). Data from IBOPE (2012) reveal that the
building material retail is in a growing stage due to the
good development of the real state sector, verified from
2005, with the financing politics of the building trade.
Between 2003 and 2008, this retail sector increased by
117% and, in the same period was placed above the
nominal increase of the GDP (78%) and the increase of
all the retail activities (106%).
In 2011, the building material retail moves around R$
86.4 billion. Class C represents the highest volume of
consume in the Brazilian building material retail. The
families with this economic profile represent 24.5% of
urban homes in the whole country. In 2011, southern
Brazil represented a consume potential for building
materials of around R$ 13.1 billion. In that region, there
are around 27 thousand commercial establishments
(IBOPE, 2012), configuring a strong competition. This
way the average of the featuring in the South is R$ 480
thousand for commercial establishment, value that is
15% below the national average, which is R$ 567
thousand for each establishment.
The National Association of Building Material
Merchants- ANAMACO, professional class association
that defends the sector interests with government entities
and fabricants of products commercialized by the
resellers has on its database around 50 thousand
registered stores, of which 56% are located in the state of
Sao Paulo; 10% in Minas; 6% in Rio de Janeiro; 4,5% in
Rio Grande do Sul; 4% in Parana, around 4% in Bahia
and 3.5% in Santa Catarina (ANAMACO, 2012). In order
to meet up with the challenging environment, some
building material retail companies act in cooperation
networks to keep the competitiveness.
Building material retail cooperation networks
Facing the changes of production, management and
distribution, there are new relations between companies
and employees, and companies and institutions. From
this new scenario, the cooperation relations are intensified
in order to reduce the difficulties that “translate how costs
of transaction for the companies, that is to say, the costs
that go beyond the production costs” (Olavee, 2001, p.
290).
Deretti et al.
Malafaia et al. (2006) mention that the cooperation
networks appear due to crisis in the traditional models of
verticalisation, requiring lean and flexible actuation for a
quick adequacy of the market conditions. The cooperation
is a strong motivator of cross-organizational (Bengtsson,
1999). Among micro, small and medium companies, the
link between the cooperation networks can be vertical,
horizontal, and laterals, composing closer relations with
the clients, suppliers, government agents and even the
competition that seeks better conditions (Zeng et al.,
2010). The horizontal networks between competitors are
common in the retail context and especially in Brazil; they
have been expanding not only for characterizing as a
survival option but also for the opportunity of innovations
generation (Bortolaso et al., 2013). Balestrin and
Verschore (2008, p. 208) highlight the horizontal
networks:
[...] formed by companies that hold each one its
independency, but choose to coordinate certain specific
activities in a cooperated way, with the following goals:
creation of new markets, costs and risks support in
researches and new products development, information
and technology managing, definition of quality brands,
interests defense, marketing actions, among others.
These networks are formed in the dimension of
cooperation of the members, that choose the flexible
formalization in order to better adapt to the nature of their
relations.
The retail environment is a propitious scenario to build
cooperation networks, specially the micro and small
companies that suffer with the difficulty of obtaining
resources (Pereira, 2004). For Martignano et al. (2005),
the building material retail in the Brazilian context suffers
deep transformations from the 90s, with the intense
dispute for better competitiveness positions among the
international groups, such as Leroy Merlin and
Castorama. This scenario also propitiates new stores
layout, as home centers that intensify the auto-service.
Furthermore, the imported goods increase due to the
economy opening and the mix of products require
adaptations of the distribution channels.
This way, understanding the strategic moves of this
sector can generate subsidies to improve the decisions
processes and a better comprehension of the
potentialities and limits. Following the example of other
segments, to adjust to the challenging environment,
micro, small, and medium entrepreneurs of the building
material retail substitute the paradigm of the individual
competition to act on a cooperated way. Pereira (2004)’s
study on marketing in cooperated networks, especially in
a building material network created in 2000 in Rio Grande
do Sul, formed initially with 11 stores, pointed many joint
activities. The study reveals that the cooperated action
improved the intern and extern communication and
management by caption, the treatment and dissemination
37
of information among the associated members. This way,
the network faces the sector’s strong competition in the
most appropriate way, while it solidifies its image and
increases the customer satisfaction. On a similar study,
Castro et al. (2011) pointed that the combat of the
industries action that sells direct to the final consumer,
without the retailer participation, was an important
conquer for an association of building material retailers in
Parana. This practice affects the sector that cannot
compete with the fabricant on equal conditions.
Currently there are four cooperation networks that
compete in the building material retail in Parana. These
networks are located in different cities and have
important role on the generation of jobs and distribution
of products, characterizing a propitious environment to
investigate the forming motivations and the results
obtained by this way of acting.
METHODOLOGICAL PROCEDURES
This research is characterized as a case study, with qualitative
approach and consists of the determination of the motivational
formation factors, the impacts on the cooperated actions and the
gains obtained by the building material retail cooperated networks
in Parana. The study is developed with the transversal perspective
of time. According to Richardson (1999, p.148), “in a study with
transversal cut, the data are collected on time based on a selected
sample to describe a population in this particular moment”.
For Yin (2010, a case study implies the investigation of a question
explored by one or more cases inside a delimited system,
comparing situations. Different from other qualitative methods, the
case study combines many sources of evidence to promote a
triangulation of information in order to explain the facts. The study
of multiple cases involves the data collection and analysis of many
cases, being useful to highlight the differences and similarities
among them (Gil, 1999; Merriam, 2009). A case study can also
present a descriptive purpose, building a detailed report of a
phenomenon, involving the configuration, structure, activity, and
relation with other phenomenon, as it is investigated in the current
study (Godoy, 1995; Yin, 2010).
The secondary data were obtained from the websites of IBGE,
connected to the building material commerce, and the studied
networks. The primary data collection was made through the writing
communication method, using a non-disguised questionnaire,
answered by a manager of each one of the four cooperation
networks formally formed in Parana, and by the managers of the
associated stores. It was distributed and collected online using the
help of the Qualtrics system. The instrument has closed questions,
with answers pointed to scales that are, according to Gil (1999,
p.139) “instruments building within the goal of measuring the
intensity of the opinions and attitudes on the most objective way
possible”.
Open questions were used, in which the respondents can freely
express themselves, giving the opportunity to explore the
information not approached on the closed questions. This structure
of the questionnaire, as well as its online hosting, considers the fact
that all the respondents are in different regions of Parana, imposing
limitations of time and access to them. In order to verify the
consistency and adequacy to the proposed study, the questionnaire
was previously tested with the manager of an informal cooperate
network in Curitiba, and also in two building material stores
connected to this network, chosen by the access and convenience
criteria.
38
Afr. J. Bus. Manage.
On this stage, it was made previous contact with the respondents,
informing them the goal of the study and motivating them to indicate
the strong and weak points of the instrument. This procedure
allowed the elaboration of the questionnaire’s final version that was
passed, after the previous contact, to the promotion of the
clarification and purposes of the study. The managers of the
cooperation networks are included in the current study.
The link that hosts the questionnaire was sent to the network
managers and redirected by them to the 145 associated retailers.
Among these retailers, 15 filled the whole instrument, characterizing
a non-probabilistic sample. The contacts with the managers were
made between June and November of 2012, contemplating
different stages and goals, such as: invitation to participate in the
research, the delivery of the data collection instrument, the delivery
of the documents explaining the study purposes, clarification of
questions about the research protocol filling, solicitations of
forwarding to the associated retailers, solicitation of additional
information. These contacts happen many times through phone
calls and emails.
The treatment of the secondary data was made through the
content description. The primary data were treated from the
analysis of the answers content issued by the cooperation networks
and stores manager. The closed questions were treated from the
indications made on the intensity and agreement scales in the data
collection instrument.
PRESENTATION AND DISCUSSION OF RESULTS
Profile of the building material retail cooperation
network
A common feature observed on the four studied
organizations refers to the typology of the cooperation
network. They are characterized as Horizontal Networks
of Business Cooperation. On this typology, the
competition is seen as similar, allowing finding common
solutions to face market difficulties (Balestro, 2004). In
fact, it was noticeable on the four networks that the main
links are the associations, that is to say, building material
retailers that, even competing in the same segment, seek
ways of using the cooperated actions. Another point that
is also a result of the studied organizations refers to the
governance structure.
All of them have managers that are exclusively
dedicated to the coordination and monitoring of the
cooperated activities. This structure allows that the retails
dedicate their routines and that the most important
decisions are taken in assemblies. On the other hand,
this formation makes the decision making progress
bureaucratic on the network scope, as described in
Provan’s and Kenis’ studies (2007).
All of the observed networks already celebrated more
than 10 years of existence, congregating a significant
number of associated stores. The biggest one is Rede
Bem Viver, with 56 associations that together bill 10 and
15 billion reais a month, and employs 900 employees in
the stores. The second biggest is Rede Constru and Cia
Maringa owing 19 associated stores but do inform the
number of employees and billing.
Motivations for the cooperate act
The organizations are built with a purpose. Yet, this
purpose can change during the existence. It is important
when analyzing an organization that is understood the
motive of their existences. The mission is “a declaration
of generic purpose, tougher, that identifies the operations
achievements of an organization and what they can offer
to the stakeholders” (Wright et al., 2000, p. 93).
Analyzing the mission declarations presented by the
networks and comparing them to the view of the
managers it is noticeable that: a) Rede Bem Viver directs
their acting to seek efficiency through the associated
action of the members, trying to get a better power of
purchase and sells, and also to achieve the regional and
national projection; b) Rede Constry and Cia Cascavel
and Rede Constru and Cia Maringa, for being in the
same brand of acting network, present the same purpose
directed to the coordination of strategic bonds on
business model and on the vision of the managers,
achieve advantages in the moment of purchase with the
suppliers; c) the Network seeks 100% partnering to
strengthen the companies that compose the network to
capacitate them to act in a more competitive way.
It is noticeable that the improvement in the competitive
development is a recurrent element on the presented
declarations, directing the difficulties on the acting of
small building material stores observed from the 90’s in
Brazil, according to the studies of Martignano et al.
(2005). This notion elaborated by the networks studied
here is explained in the studies of Wegner and Padula
(2010); they affirm that the retailing cooperate networks
can strengthen their competitive positions regarding the
competitors or even the position on the value chain when
better negotiating with the suppliers and clients.
According to Castels (2007), the organizational
transformations seek dealing with the uncertainty caused
by the changes on the economic environment, making
the companies rethink in the way of acting. Comparing
the network managers’ opinion (Table 1), it is possible to
identify their perceptions about the facts that motivate the
retailers to act on a cooperated way: a) the identification
with the other members of the networks and the intention
of obtaining easy resources are not common motivations;
b) the sales increase, the development of collective
actions, stability in the market, reduction of costs and
adaptation to the market are more important motivational
factors.
Table 1 also indicates two differences on the perception
among the network managers. Regarding affirmative 2
(the retailers participate in the network to obtain easy
resources), the average in the answers of the store
managers are 3.20, while the answers of the network
managers point 2.75, revealing a more optimistic comprehension of the retailers regarding this factor. Affirmative 5
(the retailers participate in the network to achieve stability
in the market) also presents differences. The average
Deretti et al.
39
Table 1. Comparative between the network’s and store’s managers about motivations for cooperation act and obtained results.
Motivations for the Cooperate act
Average
Obtained gains
Average
Network
Store
Network
Store
managers managers
Managers Managers
1) The retailers participate in the networks
3,50
3,67
1) The retailers increased the sales
4,25
4,07
because they identify with their members
volume.
2) The retailers participate in the network
to easily obtain resources
2,75
3,27
2) The retailers obtained risks reduction
of being overcome by the competition
4,00
3,93
3) The retailers participate in the networks
to sell more.
4,25
4,33
3) The retailers reduced the costs
4,25
3,70
4) The retailers participate in the network
to develop collective actions
4,75
4,27
4) The retailers increased
involvement with the collaborators.
the
4,00
4,13
5) The retailers participate in the network
to achieve Market stability
4,75
4,13
5) The retailers exchanged experiences
about the managing of the business.
4,75
4,40
6) The retailers participate in the networks
to reduce the costs
4,75
4,27
6) The retailers are collaborate on the
proposition of innovations to be shared
by the network members.
4,50
3,80
7) The retailers participate in the networks
to better adapt to the market changes
4,75
4,33
7) The retailers conquered better power
of negotiation with the suppliers.
4,75
4,53
General Average
4,21
4,03
General Average
4,35
4,08
Source: The Authors.
in the store managers is 4.13, while the network
managers gave an average of 4.75, revealing a more
pessimistic comprehension of the retailers regarding this
factor.
Still regarding the motivations that make the retailers
acting in a cooperated way, in the Works of the Rede
Bem Viver manager the retailers participate in this
network in order to “sell more and better, purchase better
and understand better”. For the manager of Rede
Constru and Cia Cascavel, the retailers participate in this
network to increase the buying power and act as a strong
brand in the market, since the communication actions on
TV, radio, and newspapers of the network are allowed by
the assesses of the costs and by the bonus allocation
coming from the suppliers according to the volume of
purchase. According to the manager of Rede Constru
and Cia Maringa, based on similar thing that happens
with Cascavel region, the main reason that makes the
retailers participate in the network is the purchase power
increase with the suppliers. As the manager of Rede
100% highlights, the retailers seek the cooperation to
“occupy a place in market, achieving competitive prices
with the competition”.
The motivational factors for the joint action are
important for the establishment of the cooperation levels
and the need of information Exchange among the
members. At this point in the exchange of ideas, a
strategic view is developed, and if we analyze the
problems, the common solutions and the definitions of
the performance papers among the partners are found
(Casarotto and Pires, 2001; Balestrin and Verschore,
2008).
In the organizations observed here it is verified that
before the entrance in networks the relationship among
the retailers was characterized by the high competition.
The unfolding of the cooperation view, especially those
related to the expectation of a better financial and market
development, created motivational factors that united the
studied companies, corroborating for previous studies
about such motivations for the formations of cooperation
networks (Oliver and Ebers, 1998; Bengtsson and Kock,
1999; Livato and Benedicto, 2010). It is important to
highlight that the motivation regarding the easy access to
resource (Balestrin and Verschore, 2008), in the retailers
perception, is the factor with lower relevance for the
entrance into cooperation networks.
Cooperate acting
Comparing the opinion of the network managers it is
verified as main cooperated acting implanted on the
observed organizations: development of new business
opportunities and new store managing processes, joint
40
Afr. J. Bus. Manage.
promotions of products commerce, and marketing of the
name/brand of the network in the market. Although there
are perceptions of improvement regarding the
capacitation of the human resources, this result is less
expressive comparing to the others.
The perception of the positive results seems to be more
intense in Rede Bem Viver network. As the manager of
this network highlights, the obtained results with the
member’s cooperation “in general are good and
contributed to the growth of our stores”. Still regarding the
results of the cooperated acting, according to the
manager of Rede 100% the cooperated actions help to
increase the sales, but not all the stores to achieve good
results”. According to the manager of Rede Contru and
Cia Cascavel, the visual identity strengthens the brand
and the company (associates). Beyond that, the
cooperated actions require training and consults,
improving the managing of the stores in a generic way.
The answers of the store’s managers do not reveal
bigger differences and follow the same perceptions
presented by the network’s managers.
The results of the cooperation actions presented
previously approximate to the main ideas that the
cooperation allows seeking new ways of acting and also
for the reduction of costs (Bortolaso et al., 2013),
increasing the economic efficiency. This improves the
levels of the maturity stage of the network that composes
the current study, compared to Castro et al.’s (2011)
studies, developed in an association of building material
retailers in Parana. This difference can come from the
fact that the acting in formal cooperation networks, on
which the associate share the same brand while keeping
their own legal identity, can conduce to a bigger
commitment when compared to a retailers association
that does not have the same characteristic.
Gains obtained after entering the network
Comparing the opinion of the network managers (Table
1), is possible to determine their perceptions about the
obtained gains by the retailers after entering the
networks: a) Exchange of experiences about the business
managing, the collaborative act in the position of innovations without being shared and the better negotiation
power with the suppliers are the most noticeable gains; b)
the sales increase and the reduction of operation costs
are significant gains, but are not noticed with full intensity;
c) the reduction of risks of being overcome by the
competitors and the increase in the collaborators’
involvement are gains that present more difficulties of
being conquered.
Table 1 also indicates two differences in the perceptions
among the stores managers and the network managers.
Regarding affirmative 3 (the retailers could reduce the
operation costs) the noticed average on the retailers
varies from 3.80, while the answers of the network
managers indicate 4.25. Affirmative 6 (the retailers are
collaborative in the proposition of innovations to be shared
with the network members) also presents a divergence.
The verified average in the answers of the stores
managers on this variable is 3.80, while in the perception
of the network managers is 4.50. On these two
affirmatives is verified a less optimistic perception of the
retailers.
Still regarding the gains obtained by the retailers after
entering the network, the competitive advantage seeking
is evidenced on the words of Rede Bem Viver manager
when he affirms that “the gain in purchase is not always
what the retailers want, but regarding the marketing and
apprenticeship they can get more than what was
imagined when entering”. According to the manager of
Rede Constru and Cia Cascavel, the gains appear
immediately, but are evident, especially due to the
qualification actions in the stores managing through
shared consulting. For the manager of Rede Constru and
Cia Maringa it seems there is significant improvements in
the general performance of the associated stores.
According to manager, some affiliates already thought
about changing the area due to difficulties found in the
independent act.
Although, with the capacitation a collaboration actions
that reflect on a better managing of the business, today
they are stronger to face difficulties. From previous
studies about building material retail networks (Pereira,
2004; Castro et al., 2011), the cooperate act reflects
positively in some of the specific points observed on the
networks, with a greater market power due to the
enlargement of the clients base, collective solutions of
operational problems such as storage managing and the
need of disclosure, reduction of costs and risks,
accumulation of social capital, collective apprenticeship,
and collaborative innovation through the sharing of
experiences among the members that compose the
network. Beyond that, it is evident on these reports the
improvement of the negotiation conditions with the
suppliers, also in the perspective of Castro et al. (2011),
about the practice of indiscriminate sells by the industry,
since such behavior affects the sector that cannot
compete equally with the fabricants. Contrary to the
studies of Zeng et al. (2010), that affirm the acting in
cooperation networks reduce the vulnerabilities facing the
competition with Rede Contru and Cia Maringa that still
did not conquer the advantages. Also Rede Bem Viver
did nott conquer the goal of increased involvement of the
collaborators. These data deserve a more detailed
investigation since they do not meet the expectations of
these organizations. However, the five other items that
refer to the gains are found with high intensity.
Final considerations
This study is part of a wider research, still developing,
that investigates the process of formulation and
Deretti et al.
implementation of marketing strategy in cooperation
networks in retailer segments of Parana. The study
presents a qualified step, specifically about networks that
act on the building material retail for constituting a solid
example of this way of acting. The profile of the four
formal networks on this segment of Parana is diversified
regarding the number of stores, covered area, number of
collaborators, and sales volume.
Regarding the factors of formation and the existence of
cooperation networks observed, the sales increase, the
development of collective actions, the market stability, the
reduction of costs, and the adaptation to the market are
the most important motivational factors on the search of
cooperated action, in the opinion of the network
managers. In the managers’ opinion still, the identification
with the other network members and the intention of
obtaining easy access to the resources is not a
consensus motivation. On the other hand, the search of
resources in a facilitated way is the factor with lower
relevance in the retailers’ point of view when entering the
cooperation networks. This specific point seems to be a
mismatch between the retailers’ expectations and the
focus of the managers’ actions in the networks.
Regarding the results of the cooperate actions on the
networks studied here, it is verified that the managers of
the networks highlight the new opportunities of business,
the improvement on the store managing processes, and
better promotion of name/brand of the network in the
market. Despite the fact that there are perceptions of
improvement regarding the capacitation of human
resources, this result shows less expression regarding
the others. About these results, the answers of the store’s
manager follow the same perceptions verified among the
networks’ managers.
About the obtained gains by the retailers after entering
the networks, according to the opinion of the managers,
stand out as bigger conquers the exchange of experience
about business managing, collaborative action when
proposing innovations to be shared, and a better power
of negotiation with the suppliers. Still regarding the
perception of the network’s managers, the reduction of
risks to be overcome by the competitors, and the
increase of the collaborators involvement show more
difficulty. The collaborative acting proposing innovations
to be shared with the network’s members and the
reduction of operation costs are not very intense for the
retailers, revealing a better optimism with the managers
regarding these factors.
Finally, even though there are no bigger frustrations
regarding the general expectations on the cooperated
actions, this study reveals the importance of being
considered the divergences between the perceptions of
the network’s manager, and the store’s managers on a
wider context, involving the factors of formation, results of
the cooperated actions, and the gains obtained with this
way of acting. On this context, the study shows that there
seems to be no divergences on the governance structure
41
of the organizations observed here, being an indication
that they are on a stage of maturity and stability.
Even though the study here presented has involved all
the horizontal cooperation network formally formed on the
retailing sector of building material of Parana, it is
necessary to present as limitations: a) the exploratory
approach, that can limit the comprehension of complex
situation with the organizational relations; b) the
subjectivity regarding the results measuring mentioned by
the stores’ and networks’ managers, that can constitute
the imprecision of economic and market results related;
and c) the transversal perspective used, that limits the
capitation of the relational dynamic along the existence
time of the networks. Future studies in retailing network
of diverse segments must consider these limitations and
can progress in other questions of relationships in cooperation network such as confidence and competitiveness among the associates.
Conflict of Interests
The authors have not declared any conflict of interests.
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Vol. 9(2), pp. 43-49, 28 January, 2015
DOI: 10.5897/AJBM2014.7534
Article Number: 51ED20250093
ISSN 1993-8233
Copyright © 2014
Author(s) retain the copyright of this article
http://www.academicjournals.org/AJBM
African Journal of Business Management
Full Length Research Paper
Networking for SMES in Uganda: A conceptual paper
Peter Turyakira* and Cathy Ikiror Mbidde
Department of Marketing and Management, Makerere University, Uganda.
Received 24 July, 2014; Accepted 23 January, 2015
Small and Medium Enterprises (SMEs) are considered a sector with significant contribution to the
economical growth of both developed countries and emergent countries. However, SMEs are facing
challenges for their survival with their limited resources. There is also considerable lack of empirical
studies focusing on networking between SMEs in developing countries. Promotion of networking
approaches with other organizations could be a good start to develop and increase competitiveness of
SMEs. The primary objective of this paper is to identify networking factors that influence the
competitiveness of SMEs and to develop a hypothesized model that can be tested on SMEs. The
outcomes of networking factors can help to improve the survival rate of SMEs, and may offer great
opportunities for business competitiveness, locally and globally.
Key words:Networking, small and medium-sized enterprises, competitiveness.
INTRODUCTION
Small and medium-sized enterprises (SMEs) are
universally acknowledged as effective instruments for
employment generation and economic growth (Basil,
2005; Damirchi and Rahimi, 2011; Johan, 2007). In
Uganda, SMEs play a crucial role in creating job
opportunities that make the attainment of equitable and
sustainable growth and development possible (Turyakira,
2012).
It is estimated that there are over 1,069,848 SMEs in
Uganda, providing employment and income generation
opportunities to low income earners of the economy
(Hatega, 2007; Uganda Ministry of Finance, Planning and
Economic Development July, 2011). Despite their
enormous contributions to economic growth, more than
half of SMEs in Uganda fail during their first year
(Harorimana, 2009; Tushabomwe-Kazooba, 2006).
Hence, their high failure rate is a cause for concern.
In an era characterized by global competition, technological advances and innovation, business networking
plays a vital role in increasing the competitiveness of
SMEs (Lin and Zhang, 2005). Networking is a useful way
for SME owner/managers to expand marketing expertise
and improve their performance (Hakimpoor et al., 2011).
As such, networking in form of clusters, strategic
alliances and business collaborations has become
popular among the SMEs as a competitive tool.
Although empirical studies have been done on business
networking in developed countries (Thrikawala, 2011),
little attention has been given to developing countries.
Despite the academic interest in business networking and
its impact on SMEs’ competitiveness, inadequate theoretical and empirical studies exist in Africa; particularly in
Uganda.
Therefore, the purpose of this paper is to identify
*Corresponding author. E-mail: [email protected], [email protected], [email protected].
Tel: +256-772-586327.
Authors agree that this article remain permanently open access under the terms of the Creative Commons
Attribution License 4.0 International License
44
Afr. J. Bus. Manage.
networking factors influencing the competitiveness of
SMEs and to develop a hypothesized model that can be
tested on SMEs. The paper is mainly based on a
literature synthesis of recent studies done on networking,
both in developed and developing countries. The
outcomes of networking factors can help a great deal in
improving the survival rate of SMEs, and may offer great
opportunities for business competitiveness, locally and
globally. For the purpose of this paper, small and
medium-sized enterprises in Uganda are considered as
businesses which employ more than 5 but fewer than 100
persons.
Nature and potential outcomes of networking factors
in SMEs
This section describes the nature and potential outcomes
of networking factors with respect to SMEs, as indicated
in the subsequent sub-sections.
Networking
Business network refers to a free business association,
capable of creating structures and processes, joint
decision making and integrating the efforts of members to
design and produce goods and services, and exchanging
information and other resources (Trequattrini et al.,
2012). Networking in SMEs refers to the network process
that is undertaken by SME owner-manager in managing
the business activities (Hakimpoor et al., 2011). In Niu’s
study (2010), it is argued that the benefits of networking
involvement enable trusting relationships among
businesses. Furthermore, SMEs harvest from individual
ties in their networks, including suppliers, customers,
friends and relatives, for various purposes (De Jong and
Hulsink, 2012). Relationships can be developed on the
basis of trust (Gibb, 2006).
In this paper, networking refers to a free association of
businesses with the aim of sharing information, resources
and capabilities through clusters, strategic alliances or
business collaborations. Networking involves communication and information exchange for mutual benefit
(Camarinha-Matos and Afsarmanesh, 2006).
The notion of networking has been especially attractive
as a means by which SMEs can collaborate in order to
compete more effectively in the global marketplace. Many
businesses have placed increasing emphasis on adopting
strategic alliances as a strategic competitive choice
(Akoorie and Pavlovich, 2003). Strategic alliances create
interdependence between autonomous economic units,
bringing new benefits to the partners in the form of
intangible assets.
Businesses also network through collaboration, which
involves mutual engagement of participants to solve a
problem together. This implies mutual trust and thus
takes time, effort, and dedication. A collaborative network
consists of a variety of entities that are largely autonomous, geographically distributed, and heterogeneous in
terms of their operating environment, culture, social
capital and goals, that collaborates to better achieve
common goals (Camarinha-Matos and Afsarmanesh,
2006).
Clusters as a component of networking are viewed as
geographically proximate groups of independent but
interconnected businesses in a particular field, linked by
commonalities and complementarities. They are often
concentrated in a particular national region, and sometimes in a single town, but increasingly ‘cluster of
clusters’ are emerging across regional and even national
borders. They may be collaborating or competing; and
they may be institutionalized or non-institutionalized
(European Commission, 2002).
It is argued that in an SME network, businesses that
trust their partners are more likely to engage in
networking with them. Businesses that have developed
trust towards their partners within the SME network are
more likely to turn to those businesses than try to network
with organizations outside the SME network. After all, a
business only possesses a certain amount of resources,
and networking is resource demanding (Wincent, 2005).
The success of a business relationship lies in the
development and the growth of trust and commitment
amongst partners (Brink and Berndt, 2004). Trust is the
first element needed in business relationship building and
it is the first stage in the networking process hence, the
most important aspect. Trust lays the foundation for a
common ground, where SMEs can successfully meet
their expectations (Zaheer and Harris, 2006).
The commitment of businesses to developing and
maintaining relationships is essential to cultivate the level
of trust and interdependency between partners that
motivates exchange of resources (Carson et al., 2004;
Clarke, 2006). Relationship commitment is vital as a
precursor of network development (Johanson and Vahlne,
2006). Commitment is viewed in terms of the willingness
and investment of a business in developing and
maintaining relationships with partners (Tanga, 2011).It is
empirically supported that businesses involved with
networks have a relatively higher survival and success
rate and that the primary variables influencing such
performance are inherently social in nature (Smith, 2004).
Previous studies (Cruickshank and Rolland, 2006; Inkpen
and Tsang, 2005) acknowledge that joining a strategic
network has a valuable path for SMEs striving to gain a
sustainable competitive advantage within their business
environments. It is evident that networking, whatever its
form, has an impact on a business's survival and success
(Grandori and Soda, 1995). Networks enable businesses
to concentrate on core competencies, and to achieve
economies of scale and scope through their loosely
integrated form (Smith, 2004).
According to Kariv et al. (2009), networking enhances a
Turyakira and Mbidde
business’s competitiveness. SMEs rely on their networks
to support and enhance their business efforts to be
competitive (De Klerk and Saayman, 2012). A wellnetworked business enjoys higher growth rates and
competitiveness (Hakimpoor et al., 2011). SMEs with
more open networks and diverse connections have
greater opportunities to develop successful businesses
than an individual with many connections within a single
or closed network (Harris et al., 2012).
Marketing networks serve as a means of facilitating
business activity in transition economies, and have been
widely recognised in the literature as affecting
businesses’ strategic choices and performance (Batjargal
and Liu, 2004; Chung-Leung et al., 2008). According to
Watson (2007), networking appears to be significantly
positively associated with business’s survival; and both
formal and informal networks are associated with SME
survival, but only formal networks are associated with
growth.
Although it has been emphasized that SMEs can
increase their competitiveness when participating in
strategic networks, it is hard to determine which firm has
better prospects for building competitiveness compared
to other firms in the network. Lack of this knowledge may
cause strategic SME network participants to lose interest
in the long-run and stop using these networks as a tool
for competitiveness building (Wincent, 2006). As such,
attention to factors related to competitiveness development within strategic SME networks has been limited.
Despite the potential to improve their competitiveness
when participating in an SME network, members face
external challenges, such as free riding, opportunism,
and uncertainty of outcomes, when operating with partly
independent members that can be competitors (Human
and Provan, 2000). Nevertheless, achieving a competitive
advantage position and enhancing business performance
relative to their competitors are the main objectives that
businesses in particular should strive to attain. The extent
and the strength of networks constitute a significant
competitive advantage for SMEs (Johanson and Vahlne,
2009). For the purpose of this study, competitiveness
refers to a business’s ability to sustain its long-term
performance better than its competitors in the market, as
indicated by profitability, market share, sales and growth
rate.
Traditionally, business competitiveness has been
measured using only financial indicators such as profit,
market share, sales, and growth rate (Guzmán et al.,
2012; Man et al., 2002; Singh et al., 2008). However,
many researchers have suggested the use of subjective
and objective measurements in order to measure performance, mainly because, in this context, performance,
which is relative to its industry or sector, represents an
indicator of their competitiveness level (Guzmán et al.,
2012). The survey of five owners-managers of SMEs
established that most SMEs use a hybrid approach in
measuring competitiveness due to their concerns on
45
meeting the financial as well as non-financial returns.
Financial measures include profits and sales turnover
while non-financial measures are the long-term growth
rate and market share of the business (Chong, 2008).
The financial performance can also be an effective
measure of market share (Gorynia, 2005), and is
generally defined as the return of capital, the return of
sales and the improved measures for the comparison of
the performance of businesses (Corsten and Felde,
2005). Hence, most SMEs use profitability, market share,
sales and growth rate as measures of competitiveness
over a period of time. Based on these notions, the
following hypotheses are presented:
H1a: There is a positive relationship between networking
and the SMEs’ trust.
H1b: There is a positive relationship between networking
and the commitment of SMEs.
H1c: There is a positive relationship between networking
and the competitiveness of SMEs.
Trust
Trust is an essential trait in networking (Kanagaretnam et
al., 2010). Reliance on a particular type of trust depends
on the developmental phase of the venture (Martinez and
Aldrich, 2011). It is imperative for the SMEs to maximize
the opportunities for building trust and learning from all of
the stakeholder relationships (Gibb, 2006). Trust substitutes the cost of monitoring, decreasing transaction
costs and increasing the efficiency of the collaboration
(Casals, 2011) while enhancing competitiveness. The
networks need to institutionalize the efforts to foster trust
and commitment rather than treating them to be a natural
consequence of the quality of interactions or individual
efforts of the boundary spanners (Yaqub et al., 2010).
Trust can be conceptualized both as a calculation of
risks and benefits, but also more socially, toward other
people as well as toward society as a whole (Liljeblad,
2005). According to Coote et al. (2003), trust exists when
one party has confidence in the honesty, reliability, and
integrity of their partner. Trust is an aspect that is proactively pursued by all parties concerned and is a longterm commitment that is achieved through patience and
endurance (Koot et al., 2003). As such, trust enhances
cooperation and flexibility, lowers costs and increases the
potential for businesses to share their expertise and
knowledge (Nielsen, 2005). For the purpose of this study,
trust refers to the degree of confidence the individual
partners have in the reliability, honesty, integrity,
benevolence and competence of each other.
According to Sahay (2003), a crucial relationship exists
between trust and collaboration. Trust has a positive
influence on commitment, and improves the relationship
between business partners (Narayandas and Rangan,
2004). Despite increased interest and the acknowledged
46
Afr. J. Bus. Manage.
role of trust in a business’s competitiveness, there have
not yet been any theoretically and empirically coherent
attempts to measure trust in an inter-organizational
context (Seppa¨nen et al., 2007).
Although the primary objectives of the network activities
relate to the support of business activities, social
variables such as trust have been established as the
primary determinants of the success of such business
relationships (Smith, 2004). Relationships that are built
on trust and confidence in each other are very valuable,
in that it will minimize costs involved and will help to build
sustainable competitive advantages for SMEs (Wickham,
2004). Trust also minimizes the levels of social litigation
needed and it fosters and promotes social arrangements
and contacts (Koniordos, 2005). Previous studies (Gibb,
2006) established that the entrepreneur, who had
subsequently developed the most appropriate contacts
into acquaintances, built them into transactional relationships and turned into partnerships. The partners were
then turned into friends, the friends then into “family” and
the family into networks whom he could trust and
exchange favours with. Against this background, the
following hypothesis is developed:
H2: There is a positive relationship between achieving
trust and the competitiveness of SMEs.
Commitment
Commitment has been defined and measured in different
ways over the years, and its antecedents are based
mainly on studies of dyadic relationships between
individuals or businesses (Andrésen et al., 2012).
Commitment is measured in terms of the frequency of
communication between an SME owner-manager and
each network member (Carson et al., 2004). According to
Andrésen et al. (2012), commitment is defined as the
allegiance of those representing the participating
businesses to the network as a unit. For the purpose of
this study, commitment refers to short-term sacrifices and
allegiances made by partners to the relationships in order
to realize long-term benefits. Positivistic research has led
to an understanding that the concept of commitment is
multidimensional and differentiated (McKenna, 2005). It
comprises affective commitment which reflects an
employee’s emotional attachment to, identification with,
and involvement in an organization.
Normative commitment, on the other hand, reflects the
view that an employee has a duty or an obligation to stay
with an organization. According to Da Rocha et al.
(2012), commitment has three different, but closely
related, multi-dimensional constructs: market commitment, relationship commitment and commitment to
internationalization.
Previous studies (Nolan et al., 2007) reveal that
commitment is characterized by formal yet interdependent
relationships, encompassing clear business goals with
collective accountability for delivery to give the business
a competitive edge. As such, commitment can be
attitudinal or behavioural (Andrésen et al., 2012).
Attitudinal commitment concerns the process by which
businesses come to think about their relationships, while
behavioral commitment concerns the process by which
businesses invest in their relationships (Sharma et al.,
2006). In network contexts, it is not a case of a business
tying itself to someone else in the network but rather of
psychologically binding oneself by making a commitment
or efforts to retain the relationship with the network
(Johanson and Roxenhall, 2009). Based on the anecdotal
and empirical evidence from the above, the following
relationship is hypothesized:
H3: There is a positive relationship between the
commitment of SMEs and their competitiveness.
Proposed hypothesized model
The literature study has revealed a number of networking
variables that influence the competitiveness of SMEs.
Based on these factors, the following hypothesized model
is proposed (Figure 1).
Figure 1 illustrates how the independent variable
(networking) is influenced by the mediating variables,
namely trust and commitment. These, in turn, lead to
increased competitiveness (dependent variable), which is
measured by profitability, market share, sales, and
growth rate. The various relationships hypothesized
between the independent, mediating and dependent
variables are summarized below:
H1a: There is a positive relationship between networking
and the SMEs’ trust.
H1b: There is a positive relationship between networking
and the commitment of SMEs.
H1c: There is a positive relationship between networking
and the competitiveness of SMEs.
H2: There is a positive relationship between achieving
trust and the competitiveness of SMEs.
H3: There is a positive relationship between the
commitment of SMEs and their competitiveness.
METHODOLOGY
This is a conceptual paper that will follow a quantitative
research paradigm. The hypothesized model could be
tested using SMEs in Uganda drawn from various
industrial sectors. Quantitative data could be collected
using a structured questionnaire and analyzed using
Statistical Programme for Social Scientists (SPSS) for
Windows. An exploratory factor analysis could also be
conducted, and Cronbach-alpha coefficients calculated to
Turyakira and Mbidde
Independent Variable
Mediating Variables
47
Dependent
variable
Trust
Networking
1a
H
H2
H
Competitiveness
H1b
H3
Commitment
H1c
Figure 1. Proposed hypothesized model of networking factors and competitiveness. Source: Researchers’ own
construction.
determine the discriminant validity and reliability of the
measuring instrument. Correlations could be analyzed
using Structural Equation Modeling (SEM).
CONCLUSION,
RECOMMENDATIONS
LIMITATIONS
AND
SMEs play a crucial role and are considered to be one of
the principal driving forces in the socio-economic
development of modern economies, both developed and
developing. However, with limited financial resources and
managerial capabilities, SMEs in the majority of
developing countries face tremendous difficulties to
survive. It is acknowledged that networking among SMEs
is an emerging approach to SME competitiveness in
developing countries. Building a high-value network that
makes a considerable contribution to a business' success
is extremely important in today’s competitive business
environment. As the market realities change and
businesses join forces under the umbrella of strategic
alliances, collaborations and clusters, networking is an
essential element that can increase the competitiveness
of SMEs. Successful networking is created on the
grounds of mutual trust, commitment, shared knowledge
and valuable relationships that enable businesses to
grow and survive by doing business directly with other
businesses or by referring one another. Indeed,
networking can be a business's best marketing strategy,
especially for SME owners.
While this study sheds light on the relationship between
networking and SME competitiveness, it has some
limitations that must be taken into consideration. For
example, subjective measures may be used to capture all
the variables studied, which may contain biased
responses from respondents. Literature on networking
and SME competitiveness is also lacking, especially in
developing countries like Uganda.
For SMEs to benefit from networking arrangements,
they need to establish sincere interest to their partners by
encouraging conversation. The goal of networking is to
establish long-term mutually beneficial relationships with
partners in order to boost profitability. SMEs should help
promote other businesses as well in the context of
creating mutually beneficial relationships. Governments
need to provide an enabling environment and design
policy frameworks that stimulate and accelerate forms of
inter-business collaboration. Such networking arrangements will help SMEs co-operate and develop strategic
alliances which can result in mutual benefits.
Conflict of Interests
The authors have not declared any conflict of interests.
48
Afr. J. Bus. Manage.
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doi:
http://dx.doi.org/10.4135/9781452231075.n10
Vol. 9(2), pp. 50-58, 28 January, 2015
DOI: 10.5897/AJBM2013.7299
Article Number: ECAB20950097
ISSN 1993-8233
Copyright © 2014
Author(s) retain the copyright of this article
http://www.academicjournals.org/AJBM
African Journal of Business Management
Full Length Research Paper
The relationship between some demographic variables
and leadership effectiveness among local government
managers in South Africa
Clement Bell1, Roelf Rvanniekerk2 and Petrus Nel3
1
Department of Industrial Psychology, University of Fort Hare, South Africa.
Department of Psychology, University of Nelson Mandela Metropolitan, South Africa.
3
Department of Industrial Psychology, University of the Free State, South Africa.
2
Received 29 November 2013; Accepted 26 January, 2015
Scholars have argued that demographic variables are critical factors that could also be used together
with other factors to explain the variances in the behaviour of effective leaders. They are very
significant to virtually all kinds of modern organizations. The current workforce is increasingly getting
younger and highly educated. And an increasing proportion of female managers are also found in
today’s organizations. The present study therefore, explored the relationship between some
demographic variables and leadership effectiveness among local government managers in Eastern
Cape Province. The data were collected from a sample of 222 local government managers using a selfdesigned biographical and occupational data questionnaire, and a leadership effectiveness
questionnaire adopted from Fleenor and Bryant. Leadership effectiveness was measured as a unitary
concept. The results indicated that gender, age and education have a positive and significant
relationship with leadership effectiveness. The present study therefore, recommends that, local
government departments should consider these demographic variables when assigning leadership
responsibilities to managers.
Key words: Demographic variable, gender, age, education, leadership effectiveness.
INTRODUCTION
An understanding of leadership effectiveness often varies
among different scholars (Avolio et al., 2003; Yukl, 2006).
However, it is perceived globally, as something critical for
the success of an organisation (Phipps and Prieto, 2011).
Scholars have spent more than a century trying to
understand the characteristics of effective leaders
(Zaccaro, 2007). Waldman et al. (2001) however argue
that this variable continues to attract a lot of interest in
scholarly research. Globalization and the challenges of
working in the global economy have only helped to
increase this interest. Ineffective leadership destroys the
human spirit that is critical in ensuring that the
organisation is effective (Alimo-Metcalfe and AlbanMetcalfe, 2003). Effective leadership in organisation is
*Corresponding author. E-mail: E-mail:- [email protected].
Authors agree that this article remain permanently open access under the terms of the Creative Commons
Attribution License 4.0 International License
Bell et al.
also understood as the relative lack of interpersonal
weaknesses (Collins, 2001). Furthermore, it also involves
having knowledge, and understanding of organisational
dynamics and people. Scholars have argued that
demographic variables could also be used with other
factors to explain the differences in the attributes of
effective leaders (Tsui and O’Reilly, 1989). As such,
some demographic variables such as gender, age and
education can have a significant influence on leadership
effectiveness (Chen and Francesco, 2000). These
changes challenge contemporary organisational research
to explore whether established relationships between
these variables exists (Maurer, 2001; Warr and Fay,
2001).
Statement of the problem
Several factors account for differences in the attitudes
and behaviour of effective leaders (Mitchell, 2000). The
level of education, gender and age was also identified as
important determinants. The scholar argues that these
demographic variables influence people’s values, wants
and needs, and makes them think and behave differently
(Mitchell, 2000). The South African labour market is
becoming flooded with people with high education.
Scholars argue that managers are selected mainly
because of their formal education and previous merits
(Hooijberg et al., 1997). This has created a challenge for
organisations in identifying effective leaders among
people with seemingly good qualities. These credential
requirements are seldom important, and too often, people
with high education levels do not have the competencies
to match with the job (Guion and Highhouse, 2004).
Some scholars argue that without educated, skilled and
motivated public managers, efficiency and effectiveness
will never be attained (Gildenhuys, 2004). However, the
scholar argues that, it is possible that leaders can be
educated and learn by experience to become effective
public managers. The personal qualities for effective
managers include among others, intellectual capacity
(Gildenhuys, 2004). Ineffective leadership destroys the
human spirit that is critical for ensuring organizational
effectiveness (Alimo-Metcalfe and Alban-Metcalfe, 2003).
The human outcomes of ineffective leadership include
among others, employee stress, disenchantment, lack of
creativity, cynicism, high staff turnover and poor
performance (Fincham and Rhodes, 2005). The present
study therefore, seeks to explore the relationship
between some demographic variables and leadership
effectiveness among Local Government managers.
51
2. To determine the relationship between age and
leadership effectiveness
3. To determine the relationship between education and
leadership effectiveness
Significance of the study
Establishing the relationship between some demographic
variables and leadership effectiveness could be of benefit
to organisations because they can be used together with
other factors as predictors of leaders’ behaviour. The
present study focused on the three most commonly
examined demographic variables of age, education and
gender (Murphy and Ensher, 1999). These demographic
variables are relevant because they are easily
measurable attributes (Somech, 2003). They are
associated with the underlying work-related attributes
(Jackson, 1996). And they have been shown to influence
a leader’s work behaviour (Epitropaki and Martin, 1999;
Yukl and Fu, 1999). Moreover, they influence work
perceptions and attitudes through interpersonal attraction
(Tsui and O’Reilly, 1989). As such, they are a critical
consideration to be included in the multiple factors that
measure leadership effectiveness (Somech, 2003).
Understanding this relationship can also help organisations improve their leadership development process.
Thus, they will make effective development decisions of
people suitable for leadership positions (Guion and
Highhouse, 2004). Accordingly, the foregoing extant
arguments suggest the significance of some demographic
variables on leadership effectiveness processes in
organisations.
THEORETICAL PERSPECTIVES
Social role theory
This theory argues that society prescribes different roles
to members of different groups, and such roles generally
coincide with power and status norms. When work roles
break with social roles or traditional hierarchies, this
conflict can lead to discomforting environment for the
manager (Eagly, 1987). On the one side, when employees are older than their managers, such employees
are more likely to resent and to disrespect their
managers. On the other side, younger managers may
defer older employees and may refrain from exercising
their authority in order to avoid discomfort and
disapproval. As such, these age differences dynamics
have effect on leadership effectiveness (Eagly, 1987).
Objectives of the study
Social identity
1. To determine the relationship between gender and
leadership effectiveness
Scholars adopt the social identity theory to understand
the effects of workplace diversity (Northcraft et al., 1995).
52
Afr. J. Bus. Manage.
However, a social identity theory has been used to
predict and understand how age and gender diversity
have influence on managers’ attitude and behaviour
(Jackson et al., 2003). In explaining the effects that age
and gender diversity have on a manager’s behaviour, the
basic argument could be that manager’s similarity on
visible and relatively immutable traits influence manager’s
feelings of identification (Tsui et al., 1992). Gender is one
obvious example used to illustrate how self-categorisation
may increase or decrease the attractiveness of a group to
a manager (Hoffman and Hurst, 1990). As such, it affects
the interpersonal relations between the two groups.
Effective leadership in organisations is also understood
by the relative lack of interpersonal weaknesses (Collins,
2001). During the process of self-categorisation,
managers classify themselves and others into social
categories using attributes such as age, and gender
(Williams and O’Reilly, 1998).
This process allows a person to define him or herself in
terms of social identity, and that leads to in-group or outgroup distinctions (Tajfel and Turner, 1986). Furthermore,
individuals desire to maintain a high level of self-esteem
and a positive self-identity (Tajfel, 1981; Tajfel and Turner,
1986). Individuals may seek to maximize intergroup
distinctiveness in order to maintain a positive self-identity,
and thus viewing individuals from other groups as less
trustworthy, honest or even co-operative than members
of their own group (Kramer, 1991).
Situational leadership
The situational leadership theory is regarded as a
contingency theory because it focuses on effective
leadership behaviour for a specific situation (Hersey and
Blanchard, 1988).
These scholars argue that leaders are effective to the
extent that they are able to behave appropriately in the
situation they encounter. As such, leadership
effectiveness is the outcome of interplay between leader
behaviour and situation. This therefore, depends on the
maturity of subordinates, their readiness to take
responsibility for their behaviour. This in turn, is hinged
on task and relationship behaviour. Task behaviour
relates to the extent to which subordinates have the
appropriate job knowledge and skill, and their need for
guidance and direction while relationship behaviour
denotes the extent to which subordinates are motivated
to work without having a leader’s guidance, and their
need for emotional support. A combination of high and
low levels of these individual dimensions creates four
different types of work situations, each of which is
associated with a certain leadership behaviour that is
most effective. Thus, this theory explains leadership
effectiveness from a contingency perspective (Hersey
and Blanchard, 1988).
Path-Goal theory
The Path-goal theory proposes that subordinates are
motivated by a leader only to the extent that they
perceive this individual (e.g., age, gender and education)
as helping them to attain important goals (House, 1971).
The significance of the theory is the notion that effective
leaders behave in ways that support subordinates
situations and capabilities in a way that covers up for
their weaknesses and it increases subordinates
satisfaction and their performance (House, 1996). This
theory contends that subordinates react favourably to the
leader only if they perceive this individual as helping them
to achieve their goals by clarifying the actual paths to
such rewards. Thus, effective leaders simplify the path
taken by subordinates to reach their destinations, and to
help them do so. The theory therefore, suggests that
leaders are effective to the extent that they help subordinates achieve organisational goals, and goal
achievement is instrumental to performance.
LITERATURE REVIEW
Gender and Leadership effectiveness
The value of gender in our everyday life and society has
increased substantially (Ijeoma, 2010). It was for the first
time brought about in the 1970s by the feminist scholars.
The underlying reason was to use gender as a measure
for understanding the fact that women do not behave like
men in all situations, and most importantly, that the
position of women in society varies considerably (Ijeoma,
2010). A scholar argues that leadership has been
explained mainly in terms of using male role models
(Gedney, 1999). Consequently, this has created a gap in
the development of many potential senior female leaders.
However, with the advent of women in organizations,
research on leadership has thus also included both
feminine and masculine leadership behaviours (Deal and
Stevenson, 1998). Male and female managers have been
found to be possessing different leadership attributes
which are the characteristic of their gender (Heilman et
al., 1995). The present South African working environment gives men and women similar chances to move into
leadership positions (Employment Equity Act 55, 1998).
However, the challenge is that these positions are still
generally stereotyped and therefore, are not taken
seriously by women. Leadership effectiveness is not
gender sensitive. It is the behaviour of the leader that is
important for a leadership position. There are many
characteristics that are found in both males and females
that put them in favourable positions to become effective
leaders (Gedney, 1999). Many people believed that
leadership is commonly a man’s territory (Kolb and
Judith, 1997). If women in organizations become leaders,
it is imperative that they are taken as individuals who can
Bell et al.
lead others effectively (Kanter, 1977). Both men and
women have more similarities than differences in their
leadership behaviours, and are equally effective.
Although these groups are more similar than different,
women are still having less chances of being selected as
leaders. And that similar leadership behaviour is often
perceived as more positively when shown by a male than
a female. There is no gender difference in the group
perceptions of leadership effectiveness (Gedney, 1999).
Feminine traits do not lend themselves to leading to
women viewing themselves as effective leaders. Only the
females with strong masculine attributes view themselves
as effective leaders most of the times.
Although women are accepted in leadership positions,
many men still believe that leadership is their domain.
The only reason why women are in the leadership
positions at all today is completely because of civilian
political pressure. Stereotypes often work to the
disadvantage of women. They do not satisfy with the
perceivers’ characteristics of effective leaders (Gedney,
1999). Consequently, women are not considered for
promotion and developmental opportunities in favour of
men who are more often viewed as associated with
effective leadership. There are still many challenges
which women must overcome first in order for them to be
considered as effective leaders. The gender role
stereotypes suggest that female leadership behaviour is
interpersonal-oriented and collaborative while male
leadership behaviour is task-oriented and dominating
(Cann and Siegfried, 1990). Women are thus viewed as
more participative while men are viewed as more
directive. The tendency to devalue female leaders is
higher when women are behaving autocratically than
when they are behaving in accordance with any other
style (Eagly and Johnson, 1990). Female leader
behaviours may be critically examined because of their
role conflict while men are allowed to lead in different
masculine or feminine ways without facing negative
reactions because their styles of leading are generally
viewed as legitimate (Pratch and Jacobowitz, 1996).
Therefore, male leaders are not generally limited by the
attitudinal bias of their work mates. They also argue that
if there is a generally accepted level of competence,
many of the behaviours whether they are congruent or
divergent from the male gender role, are highly likely to
be accepted in male leaders.
Consequently, female leaders are relatively limited in
the behaviours that may be seen as effective because of
the conflict they face as women and leaders (Pratch and
Jacobowitz, 1996). Because females are largely viewed
as being more change oriented, they are more accepted
as effective leaders when organizations need change
leaders in today global business environment where
change is relentless and inevitable. These arguments
therefore, lead to the following hypothesis:
Age and Leadership effectiveness
H1: Gender is associated with leadership effectiveness
among local government managers.
H2: Age is associated with leadership effectiveness
among local government managers.
53
The increasing number of young managers in different
organisations has heightened more interest in the
relationship between age and leadership behaviour
among scholars (Zacher and Frese, 2009). Most scholars
examined the impact of age on different facets of
subordinates’ behaviour (Zacher et al., 2010). The
studies on the relationship of age and leadership
behaviours have been neglected. And only limited leadership researches have been conducted in leadership
behaviour that examined age as an independent variable
(Zacher et al., 2011). Scholars believe that the
combination of age and age-related developmental tasks
such as generativity have a significant influence on
leadership behaviours and its outcomes (Peterson and
Duncan, 2007). Scholars also argue that a leader’s age
and leadership effectiveness may not be exactly related
(Ng and Feldman, 2008). The few available research
findings on the leader age and leadership effectiveness
have generally confirmed that only insignificant
relationships have been found (Vecchio and Anderson,
2009). Vecchio (1993) argues that the leader’s age and
subordinates’ satisfaction with the leader are not
significantly associated. Other scholars further argue that
there is an insignificant relationship between the leader’s
age and the subordinates’ satisfaction, and with
subordinates’ work commitment (Barbuto et al., 2007).
However, there is a significant relationship between
leader’s age and overall leader effectiveness. According
to the generativity theory (Erikson, 1950), leader
generativity is the leaders’ behaviours directed at
developing and managing subordinates of the younger
age, while focusing less on their own needs, career
developments and accomplishments. Leader generativity
is therefore; more significant for developing leadership
effectiveness at older than at younger ages because
subordinates normatively believe that older and
experienced leaders should behave in generative ways
and this cannot be done by younger leaders (Sheldon
and Kasser, 2001). The integrated impact of the leader’s
age and leader generativity on leadership effectiveness is
facilitated by the subordinates’ own perceptions of the
type of leader-member exchange (LMX) relationship,
which is an important leadership process factor (Gerstner
and Day, 1997). Scholars also argue that generative
attitudes and behaviours develop from young leaders to
old and experienced leaders (Sheldon and Kasser, 2001;
Stewart and Vandewater, 1998). Furthermore, agerelated reductions in the perception of the amount of life
time remaining leads to a selection of emotionally
important and generative goals (Carstensen, 1995).
These empirical imperatives therefore, give way to the
following hypothesis:
54
Afr. J. Bus. Manage.
Education and Leadership effectiveness
Education is one of the most effective measures of good
job performance across many different jobs (Gottfredson,
1997; Schmidt and Hunter, 1998). As such, it may be
associated with leadership effectiveness. Scholars argue
that it is a significant and predictive measure of effective
leadership (Judge et al., 2004). Education is critical for
effective leadership, and this is theoretically founded on
different leadership behaviours that need strong mental
abilities such as problem solving, planning, communicating, decision making and creative thinking (Tett et al.,
2000). Scholars argue that leadership effectiveness is
related
to
motivation,
integrity,
self-confidence,
intelligence and emotional intelligence (Goleman, 1998).
All these attributes can be increased through education.
This education helps managers to better understand
themselves and others, the emotional traits of others and
the meaning of these traits for leadership behaviour.
Scholars also believe that the style used by a leader is
one of the most critical factors of leadership that
increases leadership effectiveness (Sadeghi and Lope,
2012). A leadership style is a behaviour that a leader
reveals while guiding subordinates in the right direction
(Certo and Certo, 2006). As a consequence, leaders can
improve their style through experience, education and
training. Intelligence is perceived as a person‘s all
rounded effectiveness in activities controlled by thought
(Gedney, 1999). Intelligence is strongly related to
educational achievement (Hernstein and Murray, 1994).
Leadership and intelligence have been found to be
associated (Gedney, 1999). More than 200 studies have
been conducted and documented since 1963, and they
reveal a great deal of evidence for the notion that
leadership effectiveness is significantly related to
intelligence (Gedney, 1999).
Many public managers are not educated adequately to
meet the needs of leadership positions (Miller, 2004).
These managers are given educational support when
they are being given leadership responsibilities. Although
these public managers are accountable to the
government for their behaviours, the government also is
accountable to its managers (Miller, 2004). Accordingly,
the government must determine the educational support
its managers need in order for them to be effective in
their roles. Many state education departments and
professional organisation (e.g. leadership associations)
are now providing leadership mentoring programmes
(Miller, 2004). Providing such programmes can help to
reduce professional isolation, promote teamwork and
encourage reflective thinking. The way managers can
develop clear goals and pursue those goals in the
organisation could be achieved through aligning their
education to job responsibilities. The foregoing arguments
therefore, suggest that education is related to leadership
effectiveness. Local government managers are supposed
to be given regular training programs such as seminars
and workshops to better understand the responsibilities
and accountabilities given in the local government code.
The subject content to be covered during these education
seminars and workshops for the managers may include;
how to communicate effectively, how to co-ordinate and
give support to development projects, how to make
quality decisions and how to evaluate performance and
give feedback. It is possible that managers can be
educated and also learn by their experience to become
effective public managers (Gildenhuys, 2004). Scholars
further argue that managers are employed mainly
because of their formal education and previous merits
achieved (Hooijberg, Hunt and Dodge, 1997). These
empirical imperatives therefore, give way to the following
hypothesis:
H3: Education is associated with leadership effectiveness
among local government managers.
MATERIALS AND METHODS
Sample and procedure
The research population constituted 261 managers from local
government departments that were covered for the present study
which included Buffalo City Municipalities and Local Government
and Traditional Affairs Departments in Bisho and East London
Town, in the Eastern Cape Province, South Africa. The population
of managers constituted top-level, middle-level and lower-level
managers. The whole population participated in the present study
because it was small enough to be used as whole. As such, no
sampling method was employed to select the respondents of the
present study. To collect research data, permission was obtained
by the researchers from the top managers of local government
departments used in present study. All the managers were asked
by the researchers to participate in the present study voluntarily. As
such, all the managers were given enough time to complete the
questionnaires. Of the 261 managers that were available for the
present study, only 222 managers responded to this study.
Amongst them who responded, 53.2 percent were female
managers and 46.8 percent were male managers. With regards to
age, 17.1 percent of the managers were between the age groups
(20–29); 29.7 percent of the managers were between the age
groups (30-39) and 32.0 percent of the managers were between the
age groups (40-49). Also, 18.0 percent were of the managers were
between the age groups (50-59) and 3.2 percent of the managers
were above the age group of 60 years. With regards to their
education level, 6.8 percent of the managers had completed high
school; 5.4 percent had a certificate and 36.0 percent had a
diploma. Also, 27.3 percent had a degree and 24.3 percent had a
post-graduate degree. For reasons of confidentiality and anonymity,
the names of the managers were not assessed so that their
responses could not be assigned to specific individuals.
Instruments
Demographic variables. To assess some demographic variables
displayed by a manager, a self-designed biographical and
occupational data questionnaire was used. The questionnaire was
used to collect data on gender, age and education.
Leadership effectiveness. To measure a managers’ leadership
effectiveness, the researchers adopted Fleenor and Bryant (2002)’s
leadership effectiveness scales. This instrument has six items that
Bell et al.
Table 1. Descriptive statistics and Chi-square test
results of study variables (individual level) (N = 222).
Variable
Gender
Age
Education
Mean
1.47
3.60
4.57
SD
0.50
1.07
1.12
(X2)
30.90
155.56
130.41
P
0.006*
0.0000*
0.0000*
df
14
56
56
* p < .01.
measure possible weaknesses (derailers) that can cause a
manager to be demoted, fired or “plateaued” below the level of
standard performance. Leadership effectiveness was measured as
a low score on the derailment scales; indicating that a manager was
performing effectively in those areas in which poor performance can
lead to derailment. Sample items are, “a manager has problems
with interpersonal relationships and a manager has difficulty in
making strategic transitions” (reverse coded). The reliability level of
alpha was 0.83 which is within the acceptable level of reliability.
The respondents used a 5-point Likert-type scale ranging from
strongly disagree (1) to strongly agree (5).
RESULTS AND DISCUSSION
This section will discuss the key findings of the present
study. As such, the main findings and the relationships
between the relevant variables will be presented. A Chisquare test was employed to analyse the relationships
between the present study variables and the results are
presented in Table 1.
The first hypothesis assessed the relationship between
gender and leadership effectiveness among the local
government managers. The results shown in Table 1,
therefore found that gender and leadership effectiveness
are positively and significantly related (X2=30.90; df=14;
p=0.006). As such, both local government male and
female managers possess different effective leadership
attributes which are the characteristic of their gender
(Heilman et al., 1995). Both of them have more similarities
than differences in their leadership behaviours, and are
equally effective. The gender role stereotypes suggest
that female leadership behaviour is interpersonal-oriented
and collaborative while the male leadership behaviour is
task-oriented and dominating (Cann and Siegfried, 1990).
Local government women are therefore, viewed as more
participative while local government men are viewed as
more directive. As such, they are both effective in
leadership responsibilities. The present South African
working environment therefore, gives both men and
women in local government departments similar chances
to move into leadership positions (Employment Equity Act
55, 1998). According to the social identity theory, gender
diversity of local government managers has influence on
their work attitude and behaviour (Jackson et al., 2003).
The second hypothesis assessed the relationship
between age and leadership effectiveness among the
local government managers. The results shown in Table
1, therefore found that age and leadership effectiveness
55
are positively and significantly related (X2=155.56; df=56;
p=0.000). As such, scholars argue that there is a
significant relationship between local government
managers’ age and leader effectiveness (Barbuto et al.,
2007). According to the generativity theory, older local
government leaders’ behaviour are directed at developing
and managing subordinates of the younger age and they
focus less on their own needs, career developments and
accomplishments (Erikson, 1950). Local government
leaders generativity is therefore critical for developing
leadership effectiveness at older than at younger ages
because subordinates normatively believe that older and
experienced leaders should behave in generative ways,
and this cannot be done by younger leaders (Sheldon
and Kasser, 2001). Furthermore, the integrated
relationship of the local government leaders’ age and
leader generativity, and leadership effectiveness is
facilitated by the subordinates’ own perceptions of the
type of leader-member exchange relationship, which is
an important leadership process factor (Gerstner and Day,
1997). On the other side, young local government leaders
are also effective in local government departments
depending on the prevailing situations (Hersey and
Blanchard, 1988).
The third hypothesis proposed that there is a relationship between education and leadership effectiveness
among the local government managers. The results
shown in Table 1, therefore found that education and
leadership effectiveness are positively and significantly
related (X2=130.41; df=56; p=0.000). As such, education
is one of the most effective measures of good job
performance across local government managers’ jobs
(Gottfredson, 1997; Schmidt and Hunter, 1998). Scholars
suggest that it is a significant and predictive measure of
effective leadership (Judge et al., 2004). This is
theoretically supported by different local government
leadership behaviours that need strong cognitive abilities
such as problem solving, planning, communicating,
decision making and creative thinking (Tett et al., 2000).
Scholars also suggest that leadership effectiveness is
related to motivation, integrity, self-confidence, intelligence and emotional intelligence, and all these attributes
can be increased through education. This education
helps local government managers to better understand
themselves and others, the emotional traits of others and
the meaning of these traits for leadership behaviour
(Goleman, 1998). Furthermore, many state education
departments and professional organisation such as
leadership associations are now providing local government leadership mentoring programmes (Miller, 2004).
Providing such programmes can help to reduce
professional isolation, promote teamwork and encourage
reflective thinking among local government managers.
MANAGERIAL IMPLICATIONS
In general, the present study highlights the contributions
56
Afr. J. Bus. Manage.
of some demographic variables in determining leadership
effectiveness among Local Government managers.
Gender has a significant relationship with leadership
effectiveness. Both Local Government male and female
managers possess different effective leadership attributes
which are the characteristic of their gender (Heilman et
al., 1995). And both of them have more similarities than
differences in their leadership behaviours, and are
therefore, equally effective. The gender role stereotypes
suggest that female leadership behaviour is interpersonaloriented and collaborative while male leadership
behaviour is task-oriented and dominating (Cann and
Siegfried, 1990). Local Government women are therefore,
viewed as more participative while Local Government
men are viewed as more directive. The present study
therefore, recommends that organisations should consider
both men and woman for leadership responsibilities.
Also, age has been found to have a positive and
significant relationship with leadership effectiveness. This
therefore, means that the Local Government leaders
generativity is therefore critical for developing leadership
effectiveness at older than at younger ages because
subordinates normatively believe that older and
experienced leaders should behave in generative ways
and this cannot be done by younger leaders (Sheldon
and Kasser, 2001). On the other side, young Local
Government leaders are also effective in Local
Government departments depending on the prevailing
situations (Hersey and Blanchard, 1988). The present
study therefore, also recommends that Local Government
organisations should consider the age differences
dynamics of their managers when assigning certain task
responsibilities. Finally, education has been found to have
a positive and significant relationship with leadership
effectiveness. Education is one of the most effective
measures of good job performance across Local
Government managers’ jobs (Gottfredson, 1997; Schmidt
and Hunter, 1998). Scholars suggest that it is a
significant and predictive measure of effective leadership
in Local Government (Judge et al., 2004). This education
helps Local Government managers to better understand
themselves and others, the emotional traits of others and
the meaning of these traits for leadership behaviour
(Goleman, 1998). The present study therefore, recommends that education should also be considered when
selecting Local Government managers for leadership
roles.
Limitations and future research directions
The present study used the Local Government managers
from all the management levels as the respondents.
However, scholars argue that, it is not all the managers in
the Local Government organisations that have leadership
responsibilities (Kotter, 1990). Some managers are
regarded as leaders whereas others are not regarded as
such (Suar et al., 2006). As such, this may have
negatively affected the reliability of the results achieved in
the present study. Leadership effectiveness is perceived
as the low score on the derailment scales; in other words,
a demonstration of effective behaviours on these scales.
However, this definition covers a limited range of the
behaviours and attributes that make up the construct of
leadership effectiveness. This therefore, limits the
findings of the present study to factors used in the
derailment scales. The present study focused mainly on
the leadership effectiveness variable as a unitary concept
and as a dependent variable instead of using the
individual dimensions. Thus, it is also very important that
future studies use those dimensions that make up
leadership effectiveness construct as dependent
variables on their own. This will produce a more thorough
study as compared to the present one in respect of those
dimensions of leadership effectiveness construct.
Furthermore, the present study used self-rating measure
of leader effectiveness which may have led to normative
responses. Future studies should therefore, use a
measure of leader effectiveness in terms of results or of
perceptions of those around the leader because this may
give more reliable results.
Conflict of Interests
The authors have not declared any conflict of interests.
ACKNOWLEDGEMENT
This research was funded by the Govan Mbeki Research
and Development Centre (University of Fort Hare, South
Africa).
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Vol. 9(2), pp. 59-66, 28 January, 2015
DOI: 10.5897/AJBM2013.7171
Article Number: 4A412A250102
ISSN 1993-8233
Copyright © 2014
Author(s) retain the copyright of this article
http://www.academicjournals.org/AJBM
African Journal of Business Management
Full Length Research Paper
The impact of credit risk on profitability performance of
commercial banks in Ethiopia
Million Gizaw1*, Matewos Kebede1 and Sujata2
1
Department of Accounting and Finance, Jimma University, Ethiopia.
2
Department of Banking and Finance, Jimma University, Ethiopia.
Received 6 August, 2013; Accepted 23 January, 2015
The objective of the study was to empirically examine the impact of credit risk on profitability of
commercial banks in Ethiopia. For the purpose secondary data collected from 8 sample commercial
banks for a 12 year period (2003-2004) were collected from annual reports of respective banks and
National Bank of Ethiopia. The data were analyzed using a descriptive statics and panel data regression
model and the result showed that credit risk measures: non-performing loan, loan loss provisions and
capital adequacy have a significant impact on the profitability of commercial banks in Ethiopia. The
study suggested a need for enhancing credit risk management to maintain the prevailing profitability of
commercial banks in Ethiopia.
Key words: Commercial banks, credit risk, Ethiopia, panel data regression performance, profitability.
INTRODUCTION
Management of trade of between risks and return is
important for sustainable profitability of banks and other
financial institutions. Among risks in banking operation
credit risk which is related to substantial amount of
income generating assets is found to be important
determinant of bank performance. Hence credit risk
management capability of a bank remained a live
academic discourse in finance and economics.
Credit risk has been defined from different perspectives
by different researchers and organizations. Most
researchers agreed with the definition given by Basel
(1999) who defines it as the potential that debtor or
counter party default in satisfying contractually predetermined obligation according to the agreed up on
terms. Because failure of trading partner to repay its debt
in full can seriously damage the affair of the other
partner, credit risk always has been the vicinity of
concern throughout the world (Achou and Tenguh, 2008).
The importance of strong credit risk management for
building quality loan portfolio is of paramount importance
to robust performance of commercial banks as well as
overall economy (Charles and Kenneth, 2013). The
growing stock of literatures in finance and economics
underscores that failure in credit risk management is the
main source of banking sector crises which possibly
leads to economic failure experienced in the past
including 2008 global financial crises (Fofack, 2005;
Onaolapo, 2012, Charles and
*Corresponding author. E-mail: [email protected].
Authors agree that this article remain permanently open access under the terms of the Creative Commons
Attribution License 4.0 International License
60
Afr. J. Bus. Manage.
Kenneth, 2013). According to Onaolapo (2012), “the
Basle Committee on Banking Supervision (BCBS) (2003),
management of bank risk relates to the minimization of
the potential that a bank borrower or counter-party will fail
to meet its obligations in accordance with agreed terms”
(p.1).
Prakash and Poudel (2012) also state that credit risk
management is an important predictor of bank financial
performance. Thus success of bank performance
depends on effectiveness of credit risk management,
among other things, which leads to a surge of academic
papers on credit risk management and the effect on bank
performance albeit the context of Ethiopia and other
developing countries is scant. However there are some
studies in developing countries in Africa such as Kenya
(Angela, 2010; Danson and Adano, 2012), Gana (Samuel
et al., 2012), Nigeria (Kolapo et al., 2012; Onaolapo,
2012) and few directly related to Ethiopia (Mekasha,
2011; Tefera, 2011). Its seem difficult to infer the results
of these studies to the context of Ethiopia for the fact that
the findings are mixed. Moreover, the unique context of
commercial banks in Ethiopia such as restriction of
foreign ownership, high dominance of state owned banks,
and smallness of individual banks size may limit the
possibility of inferring existing studies to Ethiopian banks.
Hence, this study intends to explore the apparent
relationship between profitability performance and credit
risk measures from the context of Ethiopia. The finding of
this study will contribute to existing literatures on credit
risk and profitability, in addition to its managerial and
policy implications for commercial banking industry in
Ethiopia.
REVIEW OF PREVIOUS STUDIES
The relationship between credit risk and commercial
banks performance has been the concern of emerging
studies both in developed and developing countries.
From the studies on this subject matter we presented
some of the recent studies in this subsection.
Poudel (2012) studied the factors affecting commercial
bank performance in Nepal for the period of 2001 to 2012
and followed a linear regression analysis technique. The
study revealed a significant inverse relationship between
commercial bank performance measured by ROA and
credit risk measured by default rate and capital adequacy
ratio.
Hosna et al. (2009) also found similar result with
Poudel in his study of four Swedish banks covering a
period of 2000 to 2008. The result showed that rate of
non-performing loan and capital adequacy ratios was
inversely related to ROE though the degrees vary from
one bank to the other. Such inverse relationships
between profitability performance and credit risk
measures were also found in other studies (Achou and
Tenguh, 2008; Funso et al., 2012; Musyoki and Kadubo,
2012). Though there are a number of empirical studies
evidencing the negative and significance relationship of
credit risk and commercial banks performance,
concluding about this issue is somewhat difficult,
because there are papers that come across with different
results. For instance, Boahene (2012) found a positive
and significance relationship of commercial banks
performance and credit risk in his study of six Ghanaian
commercial banks covering a period of 2005-2009. The
panel data analysis model employed in the study
revealed that indicators of credit risk, namely: nonperforming loan rate, net charge-off rate, and the preprovision profit as a percentage of net total loans and
advances were positively related with profitability
measured by ROE. The author suggested that Ghanaian
commercial banks enjoy high profitability at time when
the levels of credit risk variables are high. It is reasoned
out on this study that this might be, because of
prohibitively lending/interest rate, fees and commissions.
The prevailing relationship between profitability and
credit risk is further complicated by the finding of Kithinji
(2010). Employing a regression analysis on data
collected from financial reports of commercial banks in
Kenya for the period of 2004 to 2008 concluded that
profitability of commercial banks measured by ROA did
not show significant relationship with credit risk
measures.
To the best of the researcher knowledge studies on the
relationship between credit risk and profitability
performance of Ethiopian commercial banks are few
though many studies documented that credit risk is
among the major challenges of banks in Ethiopia. Of
these studies, Tefera (2011) and Mekasha (2011) each
studied the effect of credit risk management on the
performance of commercial banks in Ethiopia. Both used
secondary data from annual reports of commercial banks
and survey of primary data from bank managers and
officers which similarly showed that there is a negative
relationship between credit risk and performance of
commercial banks in Ethiopia.
The current study
therefore aimed at contributing to the literature gap on the
subject matter by expanding the sample observation both
in time series and cross section so that a better picture of
relationship between credit risk and profitability
performance can be portrayed for commercial bank
managers and policy makers. Further, the study will
contribute to the literature by dropping the context of
Ethiopian banks.
Research problem and objective
The relationship between credit risk and commercial
banks performance has been the concern of various
studies that prove that credit risk is among the major
factors affecting profitability performance of commercial
banks (Achou and Tenguh 2008; Hosna et al., 2009;
Gizaw et al.
Mekasha 2011; Tefera 2011; Boahene, 2012; Funso et
al. 2012; Poudel, 2012; Musyoki and Kadubo, 2012).
Loan portfolio constitutes significant portion of income
earning asset. Literatures on Ethiopian banking sector
documented that credit risk and non-performing loan
have been major challenges of bank performance in
Ethiopian (Alemauhy, 1991; NBE, 2009; Tekilebirhan,
2010; Melkamu, 2012; Gethun, 2012; Mekonen, 2012).
Nonetheless, very few (Mekasha 2011; Tefera 2011)
examined the extent at which credit risk affected
profitability performance of banks in Ethiopia. The overall
objective of this study is to explore into how credit risk
affects the performance of commercial banks in Ethiopia
which is hoped to provide managerial and policy
implication to Ethiopian banking industry. Its contribution
to the literature could also be high for the fact that the
results of existing literature are not conclusive. More over
the unique nature of commercial banking in Ethiopia,
such as high state owned bank domination, nonexistence
of foreign bank could also add to literature.
In line with its general objective the paper tried to answer
the following basic research questions:
1. How far credit risk affects profitability performance of
commercial banks in Ethiopia?
2. Is there a statistically significant relationship between
NPLR and profitability of Ethiopian commercial banks
measured by ROA and ROE
3. Is there a statistically significant relationship between
LLPR and profitability of Ethiopian commercial banks
measured by ROA and ROE
4. Is there a statistically significant relationship between
CAR and profitability of Ethiopian commercial banks
measured by ROA and ROE
5. Is there a statistically significant relationship between
LTDR and profitability of Ethiopian commercial banks
measured by ROA and ROE
61
et al. (2012) in their study of “Credit risk and commercial bank
performance of Nigeria”. Kolade et al. (2012) used ROA as a
dependent variable in their model, but we used ROA and ROE, the
two most common indicators of profitability in two different models.
Moreover, we modified the model on the right hand side by adding
CAR as explanatory variable. Thus the dependent variables in this
study, profitability were measured by rate of return on asset (ROA)
and rate of return on equity (ROE). The independent variable,
credit risk, was also measured by the ratio of nonperforming loan to
total loan and advance ratio (NPLR), loan loss provision ratio
(LLPR), capital adequacy ratio (CAR) and loan to deposit ratio
(LTDR). To account for unexplained change on profitability
performance by credit risk measures used in the model error terms
was included in the model.
The models are expressed as follows,
Model 1: ROA = β0 + β1NPLR+β2CAR+ β3LAR+ β4LLPR+ е
Model 2: ROE= β0 + β1NPLR+β2CAR+ β3LAR+ β4LLPR+ е
Where,
β0= constant parameter/ constant term
Β1 - β3= coefficients of independent variables
Net n o e
ROA=
ROE=
ota Asset
Net n o e
ota o ners e uity
NPLR= Nonperforming Loan Ratio
CAR= Capital Adequacy Ratio
LAR= Loan and Advance Ratio
LLPR=Loan Loss Provision Ratio
e= error term
Definitions of variables
Return on assets (ROA)
Return on asset is the ratio of net income and total resource (asset)
of the company. It measures the efficiency of banks management in
generating profit out of its scarce resource. The more the amount of
return on assets the better the efficiency of the bank management,
which is good for the bank.
Return on equity (ROE)
RESEARCH DESIGN AND METHODOLOGY
The overall objective of this paper was to explore into the
relationship between credit risk measures and profitability
performance of commercial banks in Ethiopia. To achieve this
objective the study used a quantitative research design.
Secondary data collected from audited financial reports of
commercial banks and from national bank of Ethiopia. As of June
2012 there were 18 commercial banks operating in the country
(NBE, 2012) of which 8 banks that had been in operation from 2001
to 2012 were purposively selected which resulted in a panel data of
96 observations. A STATA software version 11 was used to
compute a descriptive statistics (mean, standard deviation,
minimum and maximum) of study variable and a panel data
regression analysis to explore the relationship between credit risk
and profitability performance.
Return on Equity (ROE) is the other variable used to measure
profitability performance. It is a ratio of net income and total equity.
It represents the rate of return generated by the o ners E uity.
Nonperforming loan ratio (NPLR)
This is the major indicator of commercial banks credit risk. It is the
ratio of Nonperforming Loan to Total Loan. It represents how much
of the banks loans and advances are becoming nonperforming
which measures the extent of credit default risk that the bank
sustained. As the amount of this ratio increase it will send bad
message for the management of the banks because it shows high
probability of none recovering the banks major asset.
Capital adequacy ratio (CAR)
Model specification
This study adapted a panel data model previously used by Kolade
Capital adequacy refers to the amount of equity and other reserves
which the bank holds against its risky assets. The purpose of this
62
Afr. J. Bus. Manage.
Table 1. Descriptive statistics of study variables.
Variable
ROA
ROE
NPLR
CAR
LTDR
LLPR
Observations
96
96
96
96
96
96
MEAN
0.0236
0.2258
0.1235
0.1153
0.7324
0.0615
Std. dev
0.00987
0.11722
0.11838
.04414
0.21787
0.0536
MIN
-0.00175
-0.01418
0.0086
0.037
0.29687
0 0.2895
MAX
0.040254
0.703521
0.535
0.294
1.60594
Sour e: Authors Co putation.
reserve is to protect the depositor from any unexpected loss. The
BASEL accord II requires banks to hold capital adequacy at least 8
percent of their risky assets.
– Watson (DW) test was used. The other important assumptions of
the OLS estimators are normality assumption that we tested using
Shapiro wilk test.
Loan and advance to deposit ratio (LTRR)
RESULT AND DISCUSSION
To measure banks liquidity this research paper employed Loan to
Deposit Ratio. This ratio indicates the ability of banks to withstand
deposit withdrawals and willingness of banks to meet loan demand
by reducing their cash assets. When the banks are more liquid,
they can reduce risk of insolvency. This ratio provides more
general information on the issue deposit because it takes no
account the mix between time and demand deposit, and other
issues. Even so, LTDR can be used as useful tools for assessing
Banks liquidity.
Loan loss provision ratio (LLPR)
A loan loss reserve is a contra income account that enables banks
to recognize in their profit and loss statements the expected loss
from a particular loan portfolio(s). Depositors are protected against
unexpected loss through capital adequacy reserve and protected
against anticipated loss through loan loss provision reserve. Under
Basel II, banks can include LLP under their capital. The basic
assumption behind LLP is that banks managers reflect their belief
to ard the bank s asset ua ity. But
ost studies found that
managers are using this reserve for different purposes like income
soothing and earning management. On this paper the loan loss
provision ratio is used to identify the level of banks managers
expectation about their asset quality in Ethiopian banking industry.
When the amount of Loan Loss Provision increases, the quality of
the assets will decrease and vice versa.
Model diagnostic test procedure
Every estimator of the model should have to meet the OLS
assumptions before the estimation is carried out. If the estimators of
the model satisfy the OLS assumptions it is possible to say the
estimators are BLUE (Best Linear Unbiased Estimators). According
to Brooks (2008), the estimators of the models should satisfy four
OLS assumptions. Accordingly we have conducted appropriate
diagnostic tests for each OLS assumptions.
First, Breusch-Pagan test was used to test the problem of
hetroskedasticity. Breusch-Pagan test assumes the error variance
is a linear function of one or more variables. To test for multicolinearity, we also checked the Variance Inflation Factor (VIF) and
tolerance level. The third assumption of the OLS estimator is no
serial correlation. To detect this problem the popular Derbin
This section of the paper is classified into description of
the study variables and results of regression analysis.
Description of the variables
To provide a clear picture of profitability performance and
credit risk indicators considered under study the
descriptive statics, namely: mean, standard deviation,
mean and maximum values computed for the sample
observation of 8 selected commercial banks for a 12
years period are summarized in Table 1.
Profitability performance of Ethiopian commercial
banks
To measure profitability performance, return on asset
(ROA) and return on Equity(ROE) were employed in the
study and the result on Table 1 showed that on average
the banks under study earned a 2.36 percent return on
asset with a 1 percent standard deviation. According to
Flamini et al. (2009) a 2 percent rate of return on asset
obtained in their study of banks in sub-Saharan African
countries was viewed as higher than that of the ROA of
banks in other parts of the world. Hence it can be argued
that Ethiopian commercial banks had been efficient
enough to generate a higher rate of return out of their
asset. Flamini et al. (2009) also argued that high
profitability of banks in sub Saharan Africa, where
Ethiopia is located, may attribute to larger bank size,
activity diversification, and private ownership. In case of
Ethiopia also Kapur and Gualu (2010) argued that
privatization contributes a lot for the profitability of
Ethiopian banking industry. On the other side, it could also
be argued that their profitability may not fully be attributed
to good performance, but Ethiopian banks might get
Gizaw et al.
advantage of less competitive nature of the banking
market which remains restricted from participation of
foreign owned banks. In line with this, Alen et al. (2011)
on their review of African financial system pointed out
that the interest rate spread among banks in east Africa,
including Ethiopia is high. Among other things, Alen et al.
(2009) contend that “The wider spreads reflect the risk a
bank is taking or the monopolistic nature of the banking
sector in the region.”(p.25). This suggests that to
maintain the prevailing high profitability commercial
banks in Ethiopia, they should identify whether the source
of their profitability attributes to real productivity and
effectiveness or just aggressive risk taking behavior so as
to maintain it in the future. Because if their profitability
largely attributes to lack of competition those Ethiopian
banks have been sheltered from foreign owned banks,
they
i fa e
ha enging future
hen Ethiopia s
accession to world trade organization finalized or the
banking sector becomes liberalized at some event.
Profitability performance measured by ROE in Table 1
also showed that Ethiopian commercial bank earned a
22.58 percent average ROE, with 7 percent of standard
deviation. At the outset this might also suggest that
Ethiopian banks had been producing good return for their
owners during the periods under study. Nevertheless,
literature of Navapan and Tripe (2003) doubts that getting
this much return on equity may not always send a good
message, but it may also result from having a small,
inefficient and less competitive market.
Credit risk measure in Ethiopian commercial banks
With regard to credit risk measures, Table 1 indicated
that the average NPLR in Ethiopia commercial banking
industry for the last 12 years was 12.35% with standard
deviations of 11.8%. The difference between minimum
value (1%) and maximum (53%) and the standard
deviations demonstrated that there existed high variability
with the NPL ratio. The result in general implied that the
accumulation of NPL which was claimed as critical
problem of the banking sector on previous studies
(Alemayhu, 1991; Zerayhu, 2005; Abraham, 2006;
Teklebrhan, 2010) showed an improvement overtime.
According to Gethun (2012) and Melkamu (2012) who
studied nonperforming loan in Ethiopian commercial
banks in recent years said it exhibited a sharp decline.
Capital adequacy ratio sho s the proportion of o ners
equity to total asset. Central banks use CAR as a
prote tion of the depositors oney fro
redit risk and
other failures. For this reason the minimum CAR is
determined by the regulatory agencies. Internationally
BASEL set 8% CAR for commercial banks. According to
National bank of Ethiopia directive No SBB/24/99 the
minimum requirement of CAR for Ethiopian banks is also
8, but the result on Table 1 indicated that the mean value
63
for the last 12 years was 11.5 % with a standard
deviation of 5 %. The minimum and maximum values
were also 3.7 and 29.4, respectively. The average
amount of CAR is higher than the minimum capital
requirement of the BASEL and NBE showing that the
bank has ability to bear loss results from loan default and
other operational shocks. However, higher CAR may also
diminish the profitability, competitive ability and growth
capability of the banks for the fact that shareholders fund
is kept idle (Ezike and Oke, 2013). Thus requires
consideration of commercial bank managers and the
national bank.
The ratio of loan and advance to deposit is the most
commonly used measure of bank liquidity. The ratio can
also indicate how far the bank used depositors fund on
credit activity which is prone to default risk. As per the
descriptive statistics in Table 1 the average LTDR of
Ethiopian banks was 73 percent (with s.dev = of 21.78
percent). The maximum and minimum values were 29.6
and 160 respectively, suggesting that the banks
concentrate on lending business which is relatively riskier
than other options to use depositor money. The
maximum value also raises a surprise on how banks lend
in excess of their total deposit and engaged in high risk
taking activity.
In this respect, Willem (2013) mentioned that there is
no international limit for the amount of LTDR ratio though
some countries required a limit to this ratio. Though
literature on finance stated that high risk and high return
are correlated, in a condition where the banking sector
was claimed to be encircled with high NPL for good
number of years (Alemayhu, 1991; Zerayhu, 2005;
Abraham, 2006), it showed a decline recently. This much
concentration on lending could lead to accepting higher
credit risk unless accompanied by a rigor credit risk
management and strong effective loan service process.
The last variable used to represent credit risk is loan
loss provision ration (LLPR). This ration shows the
default risk that the bank expects to sustain from lending
business. As per the result shown in Table 1, Ethiopian
Commercial Banks maintained an average of 6 percent
loan loss reserve amount with a standard deviation of 5.4
percent. The maximum and minimum values were also 0
and 29 % respectively. The required amount of LLPR is
determined by central banks and regulatory agencies and
the ratio differs from country to country (Angklomkliew et
al., 2009). In Ethiopia, NBE requires a reserve for loan
loss to be charged on bank revenue on the bases of the
amount of classified loan categories. Accordingly a 1, 3,
20, 65 and 100% provisions are required for loan
classified as pass, special mention, substandard, doubtful
and loss respectively. Thus, the mean value of LLPR
(refer Table 1) fall under special mention category
implying that the proportion of loan classified as high
probability to default seems low. The finding here is
consistent with the NPLR ratio in Table 1 and previous
64
Afr. J. Bus. Manage.
Table 2. Random effect estimate for Model 1.
Variables
NPLR
CAR
LTD
LLPR
C
Coefficients
-0.0761173
0.044624
-0.0005475
0.0816622
0.0232674
Standard error
(Robust)
0.0090986
0.0424872
0.006254
0.0146518
0.0064861
Probabilit
y /Z/
0.0000**
0.294
0.930
0.0000**
0.0000
Conf. interval
-.0939503
-.0386494
-.0128051
.0529453
.0105548
-.0582844
.1278974
.01171
.1103791
.0359799
R2 = 0.51; D.W= 1.19;N=96; Prob> chi2= 0.0000. Source: Authors omputation. * 5 percent level of
signifi an e; ** 1 per ent eve of signifi an e; Mode 1; ROA= β0+ β1NPLR+ β2CAR + β3L D + β4LLPR.
Model 1; ROA= 0.02-0.076NPLR+ 0.044CAR + 0.081LLPR.
studies(Gethun, 2012; Melkamu, 2012) that indicated that
NPL in Ethiopian commercial banks has started declining
which shows a decline in credit default risk or improved
credit risk management performance of the banks.
Results of regression analysis
As stated in research design and methodology section,
the study used two models to estimate the quantitative
effect of credit risk measuring variables (NPLR, LLPR,
CAR and LTDR) on profitability of commercial banks in
Ethiopia measured by ROA and ROE. The models were
tested for OLS assumptions before estimation and the
results of both models are presented in Tables 2 and 3.
To control the presence of heteroskedasticity and
autocorrelations the standard errors of the estimators are
made to be robust. As observed in Table 2, the R2 of
model 1 is 52 percent indicating that credit risk indicators,
independent variables in the model (NPLR CAR LTD and
LLPR) explained 52 percent of the variance in profitability
performance of Ethiopian commercial banks measured
by ROA.
With regard to the effect of each independent variable,
the results in Table 2 showed that, the rate of
nonperforming loan to total loan and advances (NPLR)
negatively affected profitability measured by ROA at a
0,01 level of significance. This suggests that a unit
increase in nonperforming loan amount will result in 0.07
units decrease in ROA, citrus paribus. Contrary to this,
the rate of loan loss provisions (LLPR) showed a positive
effect at a 0.05 level of significance. This means that
holding all other variables constant, a unit increase LLPR
brings a 0.08 units change on ROA. The result in Table 2
however does not reveal statistically significant effect of
CAR and LTDR on ROA.
The result from the second model (Table 3) also
showed that R2 is 46 percent suggesting that the
independent variables in the model explained 46 percent
of the variation on profitability performance measured by
ROE.
With respect to the effect of each independent
variable, the result in Table 3 indicated that NPLR and
CAR negatively affect ROE at 0.01 and 0.05 level of
significance respectively. Yet, LLPR showed positive
effect and significant at 0.01 level. Holding all other
variables constant a unit increase in the level of NPL,
ROE is expected to decrease by 0.62 units. A unit
increase in the amount of capital adequacy will also lead
to a decrease of ROE by 1.02 units.
Intriguing finding of the study is the positive effect of
LLPR on ROE as it had with ROA. Holding all other
variables constant a unit increase in the level of Loan
Loss Provision Reserve, ROE expected to increase by
0.83 units. The result in Table 3 in general showed ROE
of commercial banks in Ethiopia is highly sensitive to ratio
of nonperforming loan to total loan and advance (NPLR),
capital adequacy ratio (CAR) and loan loss provision rate
(LLPR). Yet, the effect LTDR having on ROE was not
statistically significant at all.
Discussion on regression results
The impact of nonperforming loan on profitability
Observation from Table 2 suggested that NPLR which
measures the extent of credit default risk sustained by
the banks showed a statically significant large negative
effect on profitability measured by ROA. The result in this
respect is consistent with findings of Poudel (2012);
Funso et al. (2012) and Chen (2008). Consistent with the
findings of previous studies on Ethiopian banks and
elsewhere, the criticality of credit default risk on efficient
utilization of asset by Ethiopian commercial banks
emerged from this study. The good thing is that the
descriptive statics and the observation of the trend on
NPL in Ethiopian banks as per the study of Getahun
(2012) and Melkamu (2012) showed a sharp decline
indicating that managers and policy makers in Ethiopia
have enhanced credit risk management mechanism in
the banking industry. With respect to profitability measured
by ROE which indicates how far the owners earned from
their investments in Ethiopian commercial banks, NPL
Gizaw et al.
65
Table 3. Random effect estimate for Model 2.
Variables
NPLR
CAR
LTDR
LLPR
C
Coefficients
-.619229
-1.021093
-.0677818
.8317095
.4185701
Standard error
(Robust)
.121868
.4004441
.0667983
.2387132
.0926247
Probability
/Z/
0.000**
0.011*
0.257
0.001*
0.000
Conf. Interval
-.8580859
-1.805949
-.1893091
.3638402
.2370291
-.380372
-.236237
.0537454
1.299579
.6001111
R2 = 0.46; D.W= 1.51; N=96; Prob> chi2 = 0.0000; Source: Authors computation.* 5 percent level of
signifi an e; ** 1 per ent eve of signifi an e. Mode 2; ROE= β0+ β1NPLR+ β2CAR + β3L D +
β4LLPR; Mode 2; ROE= .042 - .62NPLR -1.2CAR + .83LLPR.
showed a significant negative effect. The Negative impact
of NPLR on ROE is supported by the finding of Achou
and Enguh, (2008). However compared with the impact
of NPL on ROA, the impact is high on ROE.
The result in this study therefore, suggested the need
for strong credit risk and loan service process
management must be adopted to keep the level of NPL
as low as possible which will enable to maintain the high
profitability of commercial banks in Ethiopia.
The impact of loan loss provisions ratio (LLPR) on
profitability
Surprisingly, loan loss provisions ratio which is a forward
looking measure of credit risk is found to have a
significant positive effect on profitability measured by
both ROA and ROE. This might suggest that the lending
business in Ethiopian banks as presumed by mangers is
risky though it could turn to high profit. Despite such
expectation, the sharp decline in NPL (Getahun, 2012;
Melkamu, 2012) could also suggest that the managers
clearly recognized the risk arising from lending business
and strengthen their credit risk management capability in
addition to allowing high loan loss provisions to loan and
advances.
The alternative explanation as per Liu and Hu (2012)
might be that a positive relationship between performance
and LLPR of commercial banks signals the use of LLPR
for the purpose of earning management. Earnings
management is defined by Healy and Wahlen (1999)
cited in Muhammad et al. (2012) as a distortion to real
reflections of economic events that take place in an
organization through the use of managerial judgment.
Though taking the alternative to the context of Ethiopian
banks demands a further investigation, it is possible to
suggest strict consideration of regulatory for the fact
studies in different countries (Anandarajan et al., 2003;
Muhammad et al., 2012) conclude that positive
relationship between LLPR and profitability showed the
presence of earning management by the management.
The effect of capital adequacy ratio (CAR) on
profitability
Consistent
ith the findings of Büyükşa var ı and
Abdioğ u (2011) and Qin and Dickson (2012), this study
showed that CAR has a significant negative effect on
ROE, but not on ROA. Holding all other explanatory
variables constant, a one unit increase in CAR, ROE is
expected to decrease by 1.02 units, which is an inverses
relationship. In this respect, Ezike and Oke (2013)
mentioned that holding capital beyond the optimal level
would inversely affect the efficiency and profitability of
commercial banks. Though the minimum CAR
requirement of commercial banks in Ethiopia is 8%, the
descriptive statics in Table 1 indicated the average CAR
of the banks under study was about 11.5%, higher than
the minimum requirement. Taking the argument by Ezike
and Oke (2013) the prevailing negative relationship
between CAR and Profitability (ROE) appears to result
from having reserve beyond the necessary amount
enough to handle unexpected risk the banks may
encounter.
The other independent variable which is used to
measure the liquidity level and its impact on the banks is
not significant at 1, 5 and 10 percent level of significance
and it is not possible to infer it.
CONCLUSION AND SUGGESTIONS
The paper tries to identify the prevailing relationship
between credit risk and profitability performance of
commercial banks in Ethiopia. Previous studies in
Ethiopia were very few and studies in general were
inconclusive. Motivated to fill this gap a descriptive statics
and panel data regression analysis were employed on
secondary data collected from 8 commercial banks for a
12 years period (2003-2012).
The result revealed that credit risk profile of Ethiopian
banks had been improving during the study period. The
ratio of nonperforming loan and loan loss provision ratio
66
Afr. J. Bus. Manage.
are sharply declining in recent past. Even as the NPL
reached minimum, the LLPR is about 6 %. The capital
adequacy ratio of commercial banks was also found a
little bit higher than regulatory requirement at local and
international level, but the descriptive analysis indicated
commercial banks in Ethiopia have adequate capital to
withstand shocks resulting from credit and other
operational risks.
This study found that credit risk measures: nonperforming loan, loan loss provisions and capital
adequacy have a significant impact on the profitability of
commercial banks in Ethiopia.
Having the significant overall effect credit risk on
profitability of commercial banks in Ethiopia, it is
suggested that a rigor credit risk management process is
of paramount importance. Hence managers are advised
to employee a modern credit risk management technique
and diversify the earning activity of their respective
banks. The significant positive relationship between Loan
loss provision and commercial banks performance on this
study might indicates the presence of potential earning
management activities by bank managers.
Conflict of Interests
The authors have not declared any conflict of interests.
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